The joys of costing: part 2

In the second part of our back to basics on costing, we delve into the other types of costing methods that are available to businesses (and explained in the CA qualification). This is a helpful look at methodologies for any business management refreshers.

Standard Costing

Many people remember standard costing as the “variances module” (BM module three). In this module we introduced you to the concept of variances that exist between your budgeted profit and your actual profit.

There are two variances for sales, two for material, two for labour and one for fixed overheads.

Sales volume contribution variance

This measures the impact on profit of actually selling more or less units than you had budgeted.

Sales price variance

This measures the impact on profit of an actual higher or lower sales price compared to the sales price you budgeted.

Material price variance

This measures the impact on profit of your materials actually costing you more per kg than you budgeted.

Material usage variance

This measures the impact on profit of actually using more kg of materials than you budgeted for.

Labour rate variance

This measures the impact on profit of actually paying your staff more or less per hour than you budgeted.

Labour efficiency variance

This measures the impact on profit of your labour force taking more or less time to complete the work than you budgeted.

Fixed overhead variance

This measures the impact on profit of spending more or less on your fixed overheads than budgeted.

It is possible to reconcile your budgeted profit and your actual profit by calculating these variances.

Costs and revenues

BM module two goes into depth about a number of different types of cost. The distinction between fixed and variable costs, and how they behave in line with activity, is vital to your understanding of costing methods. In addition, you need to be comfortable with the concepts of controllable, sunk, and opportunity costs, and when these are relevant to decision-making.

Overhead Accounting

Module four, overhead accounting, looks at the process of accounting for your overheads, or indirect costs. There is a three step process in module four for any overhead cost that the business has:

Step One: allocate or apportion

This is where you either allocate a cost directly into a department (eg allocating the depreciation of a department asset directly against that department) or if it’s not possible to allocate, then you apportion a cost into a department.

Apportion means share: you share the costs out between different departments using some sort of relevant basis. For example, a rent cost could be shared amongst the different departments based on the area that each department occupies.

Step Two: re-apportion

Once you have allocated or apportioned your costs via Step 1, you need to focus on any service department costs eg maintenance or canteen, and re-apportion these service department costs into production departments.

You can either re-apportion the service department costs directly into the production departments, or indirectly.

Step Three: absorb

Once Steps one and two have been completed, the production department costs are absorbed into the product cost, via OAR (overhead absorption rate).

Activity Based Costing (ABC)

BM module ten considers ABC, which is best summed up in our infographic.

Process Costing

The final costing method considered in BM is module 11 – process costing. This method is ideal for businesses that perform repeated processes or mass production industries, and is particularly beneficial if the business has a high level of work in progress (WIP).

You need to work out the number of equivalent units that a business has, which is based on the number of completed items and partially completed items. Then by establishing the cost per equivalent unit, you can easily assign costs to finished goods and WIP as required.